After watching as they missed both their employment and inflation targets, the Federal Reserve pronounced themselves ready to act, but in the same sluggish, ineffective ways they have over the past couple years:
Fed officials could take some actions in combination or one after another. Fed Chairman Ben Bernanke, in testimony to Congress last week, listed several options under consideration, including a new program of buying mortgage-backed or Treasury securities, new commitments to keep short-term interest rates near zero beyond 2014 or an effort to push already-low benchmark short-term interest rates even lower.
Determined to keep trying to get the economy going without causing inflation, the Fed is exploring other novel measures. One idea mentioned by Mr. Bernanke in his testimony would be to use a facility the Fed calls its discount window to provide cheap credit directly to banks that make new business or consumer loans. But it isn’t clear such a program would do much good when banks already have ample access to cheap credit and this kind of program doesn’t appear to be winning favor at the moment.
Right, it’s not that banks are wanting for cheap credit. And the problem with lending is the lack of consumer demand leading to a lack of business demand for loans.
Sebastian Mallaby brings up another option, for the Fed to set a higher inflation target. But while I’ve generally favored this idea, I found this piece from Dan Kervick compelling, in particular the part about how there’s no legitimate reason that inflation must go up to get growth in our economy.
I just can’t believe that there is any significant number of real-world business people who currently espy a landscape of promising economic opportunity, but who are being scared off of investment by some vague fears that the Fed might do some vague something-or-other in the future to tamp down demand and price pressure, employing some vague and mysterious Fed mechanisms. I can’t say nobody thinks this way, but my guess is that it is mainly some economists – not the bustling hordes of everyday business folk who pay barely any attention to the yada-yadas and blah-blahs emitted by the Fed.
But while this is true, and while Kervick is right to say that fiscal accommodation that raises aggregate demand is the tool to spur growth, the US government has made it crystal clear that they will not lift a finger. Given that, it’s OK to turn to the central bank without committing an act of neoliberal economic heresy. And there are at least two ways the Fed could act that I would find more than beneficial. Mallaby, in his inflation-targeting post, identifies one of them:
One possible measure is to cancel interest on excess reserves. At present, the Fed pays 25 basis points to banks that deposit cash with it, a perverse reward for keeping money inert. Eliminating that incentive might steer cash into the real economy.
Mallaby discounts this by saying that money would flow into money markets, which may “break the buck” again. But I don’t really see that concern. The flight to safety has flowed into government Treasury bonds, not money markets.
The bigger potential Fed move would be to relieve borrowing costs on local governments by purchasing municipal bonds. This would save local governments billions (as much as $75 billion a year, by one analysis), money that would move directly into the real economy by averting layoffs and even embarking on new projects.
I’m not confident that the Fed will pay attention to any of this, but it’s important to know there are options. The Federal Reserve has failed at its goals and put its fealty to the banks above the real economy. And that’s why the House will pass a GAO audit of them today.